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The Nominal Illusion

Nearly half of workers surveyed derive satisfaction from nominal wage growth – Professional economists focus on real wages, yet a survey studying the psychology of inflation suggests nominal wages matter.1 

Inflation can incite nominal and real wage growth – When inflation results from a positive change in aggregate demand and the labor force has bargaining power, workers demand higher wages.

Wage growth in lower income cohorts can stimulate demand – Low and middle income cohorts have a higher marginal propensity to spend than high income cohorts.2

Equities in a period of positive nominal growth can be an inflation hedge – The playbook for markets of the last 30 years should be discarded for periods in history when nominal GDP (gross domestic product) was in the double digits.


The money illusion is an economic theory positing that people have a tendency to view their wealth and income in nominal dollar terms, rather than real terms. Drivers often cited for this phenomenon are a lack of financial education and lags that exist in processing price information in the real world.

Yale economist Robert Shiller conducted a survey in 1996 in which he sought to understand how consumers viewed inflation. One of the questions had to do with the psychology of inflation:

20220322-chart-1The results of economists and the general population surveyed are strikingly different. Economists overwhelmingly disagree with the statement that a nominal (but zero real) wage increase is satisfactory. Non-economists are split on the answer: 49% of individuals agree while 41% disagree. The data suggest nominal wage increases have a positive effect on consumer psychology, at least for some part of the population.

So why is that important now? These effects, when combined with demand-led inflation and wage growth in lower and middle income cohorts, can exert upward pressure on demand and stimulate economic growth.

Wages Are Increasing – According to the US Bureau of Labor Statistics (BLS) private nonfarm payrolls reports, real wages are actually on trend. The rate of increase from the July 2008 low is maintained thus far through the COVID-19 crisis, with real wages increasing +2.3% from December 2019 to-date.

20220322-chart-2According to the Federal Reserve Bank of Atlanta (Atlanta Fed) wage tracker, the majority of the wage growth is localized in the bottom quartile of income earners. As of February 2022, the bottom quartile of earners have seen a 12 month moving average year-over-year median of +5.9% wage growth, while the top quartile has seen only +3.2%. This is a key insight as the low and middle earner cohorts have a greater marginal propensity to spend than the higher earner cohorts.2

20220322-chart-3We believe this effect may have a continued effect on interest rates as well. A paper presented at last year’s Jackson Hole Economic Symposium supported the idea that a lower neutral rate of interest is related more to income inequality than worsening demographics.3 The idea is that very wealthy cohorts have a lower marginal propensity to spend and rather invest their savings, whereas lower wealth cohorts tend to spend their wage growth. If the relationship holds, wage growth in the bottom half of income earners should stimulate growth and raise the neutral rate of interest.

Inflation Narrative Versus Reality – The overwhelming market narrative around inflation today is that it’s bad for the economy and all asset classes except perhaps Commodities and TIPS (treasury inflation-protected securities), and might even crash stocks via a Paul Volcker-style interest rate hike sequence or simply destroy aggregate demand. This is likely because most market pundits and participants haven’t invested during a period of moderate to high sustained inflation. Let’s take a look at how stocks, bonds and commodities traded during the period between the recessions of 1973-74 and 1981-82, a six year sequence where the Consumer Price Index compounded at almost 8% per annum.

20220322-chart-4Both Oil and the S&P 500 compounded at 15%, Real Estate and the Bloomberg Commodities Index each at 9%, and T-Bills, T-Bonds and Corporates each at 6%, 2%, and 5%, respectively. Based on this historical analog, equities in aggregate faired just as well as oil which saw two massive supply shocks bookending this time frame.

While the hyper growth context of the equity market that has traded at nosebleed valuations has finally begun to discount this new higher interest rate regime, it’s important to remember that not all equities are hyper growth. A balanced portfolio construction process may provide better resilience when undergoing a macroeconomic regime shift.

If aggregate demand remains strong as the global economy reopens from the COVID-19 crisis (which current leading indicators continue to demonstrate), the dynamics of a demand-led inflation spike on higher wage growth and better subsequent demand could begin to change the narrative to be positive for equities in 2022.

Important Disclosures & Definitions

An investor should consider the investment objectives, risks, charges and expenses carefully before investing. To obtain a prospectus containing this and other information, call 1-866-759-5679 or visit www.alpsfunds.com. Read the prospectus carefully before investing.

Performance data quoted represents past performance. Past performance is no guarantee of future results; current performance may be higher or lower than performance quoted.

All investments are subject to risks, including the loss of money and the possible loss of the entire principal amount invested. Additional information regarding the risks of this investment is available in the prospectus.

1 Source: Shiller, R. (1997). Why Do People Dislike Inflation? Universe of Chicago Press, Reducing Inflation: Motivation and Strategy, 13-69.

2 Source: Fisher, J., Johnson, D., Smeeding, T., Thompson, J. (2019). Estimating the Marginal Propensity to Consume Using the Distributions of Income, Consumption and Wealth, Federal Reserve of Boston Working Papers, No. 19-4.

3 Source: Atif Mian, Ludwig Straub, and Amir Sufi, “What Explains the Decline in r*? Rising Income Inequality versus Demographic Shifts,” University of Chicago Booth School of Business, Working paper, August 2021.

Baa-rated Corporate Bond: corporate bonds can receive ratings that range from a high of Aaa to a low of C. Bonds given the Baa rating are considered as medium-grade obligations, meaning they are neither highly protected nor poorly secured. Bonds rated Baa and above are considered investment grade.

Bloomberg Commodity Index: an unmanaged index used as a measurement of change in commodity market conditions based on the performance of a basket of different commodities. One may not invest directly in an index.

Consumer Price Index (CPI): a measure of the average change over time in the prices paid by urban consumers for a representative basket of consumer goods and services. One may not invest directly in an index.

Nominal: a measure before considering the impact of inflation.

Real: a measure after considering the impact of inflation.

S&P 500 Index: widely regarded as the best single gauge of large-cap US equities. The index includes 500 leading companies and covers approximately 80% of available market capitalization. One may not invest directly in an index.

US 3-Month T-Bill: U.S. Treasury bills maturing in 0 to 3 months.

US T-Bond: treasury bonds (T-bonds) are government debt securities issued by the US Federal government that have maturities greater than 20 years. T-bonds earn periodic interest until maturity, at which point the owner is also paid a par amount equal to the principal.

Distributed by ALPS Portfolio Solutions Distributor, Inc.

APS001931  04/30/2023

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